Market Overview

HITE Hedge calls on ENB to materially increase offers for EEQ and EEP

Share:

The following describes the case that ENB's offer for EEQ and EEP is
materially below fair market value and is presented by HITE Hedge Asset
Management LLC. Tickers mentioned: EEP, EEQ, ENB, and KMR.

Dear members of the ENB Board and Special Committees of EEP and EEQ:

On May 17, 2018 Enbridge Inc. ("ENB") proposed to acquire Enbridge
Energy Management, LLC ("EEQ") and Enbridge Partners, LP ("EEP") in
exchange for ENB shares with no premium to severely depressed prior
closing prices. This no-premium offer is highly unusual within the
midstream space and we believe it dramatically undervalues the assets
held at these entities. We believe each merits an exchange ratio of at
least
.37 ENB shares per unit or share. This is the minimum required
to reflect fair value of these assets and to show a modicum of decency
to the longsuffering holders of these securities. This would represent a
20% increase in consideration for EEP and a 28% increase for EEQ, but
less than 2% dilution for ENB versus the current offer.

Fair value for EEP is at least 20-30% above ENB's offer

Enbridge describes EEP on its investor relations web site as "a
pure-play liquids pipeline MLP with premium
low-risk assets
, a strong financial position, conservative
distribution coverage and visible growth." Despite such laudatory
language throughout its communications, ENB now proposes to acquire
these assets at a steep discount to the valuation of every other large
long-haul pipeline company. For comparison, the proposal would value EEP
and EEQ at about 10X estimated forward EBITDA compared with a range of
11X to 15X for comparable long-haul pipeline MLPs. The offer would need
to move up about 20% for EEP and 28% for EEQ just to reach the lower end
of this range.

This is before considering several recent positive developments specific
to EEP:

  • 5% improvement in forward cash flow from FERC clarifications
  • Substantial progress on the Line 3 replacement project
  • Growing confidence in Bakken growth – note that most Bakken-levered
    midstream companies are up 20-45% YTD on a total return basis compared
    with negative 10% for EEP

After considering these fundamental improvements and substantial
derisking of major projects, ENB's offers imply a valuation of just 9.5X
run-rate EBITDA. On its second quarter earnings call, management
described its offers as "strong" and highlighted the increase in their
value due to ENB's share appreciation. We ask the Special Committees: is
an offer that values EEP and EEQ far below comparable MLPs strong? Does
appreciation in-line with the broader MLP space reflect the major
fundamental improvements specifically experienced by EEP and EEQ since
the offer announcement?

One share of EEQ = one share of EEP. Any exchange offer needs
to be equivalent

EEQ was structured and sold as a tracking security for EEP that shields
investors from EEP's K-1 and associated tax complications. EEQ's IPO
prospectus makes clear that the economic value of EEQ's holdings and its
distributions will always be equivalent to that of EEP. Due to trading
inefficiency, EEQ shares have traded at modest premiums or discounts to
EEP units over time, but the intrinsic value is clear. A comparable
transaction occurred in 2014 when Kinder Morgan Inc. bought in its MLP
subsidiaries. Kinder did the right thing and offered i-unit holder KMR
parity with the offer it made for common equity, despite its trading at
a 4% discount at the time.

Though detailed legal analysis would be required to confirm, language in
EEQ's formation documents suggest that the offer as currently
constructed might also constitute a breach of contract between EEP and
EEQ. As EEQ's initial public offering prospectus notes, EEP will not
take any action that results in a "special event", which includes among
other things, "the merger of Enbridge Partners with another entity …
unless in the transaction the only consideration that the owners of
common units receive in exchange for their common units is a security
that has in all material respects the same rights and privileges as the
common units and/or cash."
Since ENB does not have the same rights
and privileges as EEP common units, it appears an exchange of ENB shares
for EEP units would constitute a special event. ENB has some ability to
cause such a special event to occur, but according to the prospectus, "The
purchase price for the shares in the event of a purchase by Enbridge
Inc. upon the occurrence of a special event will be equal to the higher
of the average market price of the shares and the Class A [EEP] common
units as determined for a 10-trading day period ending on the trading
day immediately prior to the date of the applicable event."

In light of these facts, it is unimaginable that the EEQ conflicts
committee would accept an offer less than what is approved by EEP.

ENB has consistently described EEP and EEQ as having premium assets,
now they need to make an offer to match

Since its IPO in 1992, EEP has provided investors with a total return
less than one quarter that of ENB. Over the past decade, EEP has missed
one of the all-time great equity bull markets entirely, delivering a
paltry 1% annual total return, compared with 7.5% for the MLP sector and
8.9% for ENB. Throughout this flagging performance and particularly
during the 2016-2017 downturn, ENB management consistently described EEP
as stable and unfairly punished by markets. Now ENB proposes to take
these "premium low-risk assets" from investors at a price far below
where it traded even during the dark days of $30 crude oil, and far
below the valuation of its peers today.

We would like to ask Enbridge management which of the following is true:
Are these premium assets as its investor relations website even now
claims and therefore deserving of a premium valuation? Or are they the
worst long-haul assets in North America by a wide margin as the current
offer implies?

We agree with ENB that simplification of the Enbridge structure is in
the best interest of all shareholders and unitholders, but this
simplification must occur in a manner that at least approximates fair
value. We hope that based on their own prior remarks that ENB management
recognizes the severe undervaluation implied by its initial offer for
these securities and merely intended the proposal to start a negotiation
process. However, it is up to the Special Committees and unaffiliated
investors to hold them to account and fight for fair value.

Sincerely,

Matt Niblack, Portfolio Manager

HITE Hedge Asset Management LLC
One Gateway Center

300 Washington Street, Suite 308
Newton, MA 02458

Note: All prices and valuations based on closing prices on August 2,
2018 and HITE Hedge Asset Management estimates as of that date. This
publication does not constitute investment advice.

View Comments and Join the Discussion!